How DC schemes should approach smart beta

Pensions Expert: How should DC trustees go about choosing between multi-factor products and individual factors?

If it is good for DB, why should it not be good for DC? You are trying to generate slightly higher returns, you are trying to reduce costs

Eric Shirbini, ERI Scientific Beta

Alan Pickering: The investment community has turned the defined contribution investor into something of a Cinderella in recent years because it has been so easy to go for the large, already accumulated pots of defined benefit assets with engaged sponsors and trustees who are well advised.

Now is the time that we should be switching the focus away from being DB-centric to try and see which of the lessons that we have learnt in DB land can be applied in DC land.

Paul Black: Over the past few years, there has been a gradual change in that the asset management community has been focusing on DC as well as DB.

Then on smart beta, the idea of picking out individual factors probably does not really sit well for what is a product that is designed for the average member, who will be there for the long term. Something that combines as many factors as possible is probably the best way for most to go.

Eric Shirbini: I agree on using multi-factor products. Also, to reiterate Alan’s point, if it is good for DB, why should it not be good for DC? It is for exactly the same reasons: you are trying to generate slightly higher returns, you are trying to reduce costs, you are trying to generate higher yield. The hurdle is education. It is really a question of getting to grips with what it is about.

Plain vanilla products are probably more suitable, because you are not trying to mix or customise your smart beta product with specific active funds. A DB scheme may have a whole range of active funds, so it may want to find particular factors that fit in. A DC scheme will probably be looking at this to try to reduce costs and improve returns.

Black: In the DC world, you want something that is there for the longer term. You do not want to be tinkering with it quite as frequently as in DB.

Pensions Expert: Will smart beta will become more popular in DC?

Shirbini: I think so, because the products exist; it is really just getting trustees on board.

Pickering: But because it is educating the engaged and informed, we have to spend time focusing on what is under the label and what it is intended to do.

ESG data will probably, at some point, be used in a more systematic way and could potentially be used more efficiently to build factors

Julien Barral, bfinance

Pensions Expert: Can environmental, social and governance investing be classed as a factor?

Shirbini: Being a business school, we look at the academic research first, and it’s certainly not the case today. If you look at ESG funds and non-ESG funds, then there is no clear evidence to suggest that ESG funds do better than non-ESG funds.

At the moment, ESG is not a risk factor; that is what the evidence suggests. But if one day it does become a risk factor, it could actually end up being the other way around, that holding non-ESG means you are holding something riskier, something that can potentially go wrong, so investors would expect a better return for that.

Black: ESG has moved on from what was called ethical funds previously. These were very different beasts that involved negative screening. What that meant was that if two or three industries performed very well then ethical funds underperformed and vice versa.

I see ESG now as a much wider concept, including looking at companies’ governance. Environmental factors are obviously key. Maybe it is a case of looking at each of those factors individually.

James Price: Over the next 10-15 years, companies that exhibit good features on sustainability traits are going to be desirable to own and are going to see themselves getting re-rated and so forth. That presents an opportunity for investors who can say, ‘I understand that in the short term, there will be volatility, but I think over 15 years I will receive some additional return for it’. 

Shirbini: It is difficult to know whether it is going to play out or not. We are not saying that it is not a good thing to do; of course you should get involved in ESG investing. Our approach has been really to say, ‘Why do we not do ESG in smart beta’?

The idea is that, while this ESG plays out, you can still capture the additional return you get through smart beta. Furthermore, it might incentivise more investors to do it, knowing that they are doing something good.

Pickering: As a trustee, I am much more comfortable now the focus is transitioning from ethical to ESG, because ethical was all about what you produced, and as a trustee I have to take the view that if the law allows you to produce it, it must be legal, and if it is legal, it is investible.

But ESG is focusing more on how your business is governed rather than what your business produces.

Price: At the moment, ESG is somewhat artificially classified as an extra. The reality is, it is no different from investing; it is just doing good investing.

When we are looking at managers, whether they are quantitative or whether they are discretionary and just fundamental stock pickers, looking at these kinds of issues is how you should go about evaluating your investments; it should not really be a special kind of add-on.

I think we will probably transition over time to where everyone assumes that these issues are assessed – it will be odd that you are not including ESG in your investment decisions.

Shirbini: Your argument is certainly true in Europe. But I have done a lot of work in the US where those issues are treated as secondary issues, so it also depends where you look.

Julien Barral: To some extent a quality factor can integrate some element of ESG as it can look at governance, for instance, on a systematic basis, which is not necessarily easy.

In recent years, ESG has been evolving to become less about exclusion and more about engaging with companies, looking at how they are run rather than what they produce or the sector they belong to – that does not necessarily gel so well with smart beta.

The data available and providers on ESG are i